The Responsible Financial Innovation Act was introduced recently by United States (US) senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) to pave the way for a comprehensive framework to regulate digital assets in the US. The bill can serve as a blueprint for India’s own law regarding digital assets which is currently under deliberation.
One of the key provisions in the draft states that the Commodity Futures Trading Commission (CFTC) will have authority over digital asset spot markets. The draft said that the mandate “aligns well with their [the CFTC’s] current purview over other commodity markets.”
“Digital assets that meet the definition of a commodity, such as bitcoin and ether, which comprise more than half of digital asset market capitalization, will be regulated by the CFTC,” read a statement released by Gillibrand and Lummis.
Why it matters: India has seen sizable growth in the number of crypto investors making it pertinent for the government to regulate these digital assets. However, there is no law regulating crypto in India as the government continues to work on drafting legislation on it. The Lummis-Gillibrand bill can prove to be a reliable reference point for the Indian government.
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What are the salient features of the bill?
Revisiting taxation
How has the US treated taxation: The bill looks at providing a structure for taxation of digital assets which includes a de minimis, or minimal, exclusion of $200.
- “The amount of gain or loss excluded from gross income under subsection (a) with respect to a disposition shall not exceed $200,” read the draft of the bill reviewed by MediaNama.
- There is also a provision which stipulates that gross income (on which tax is computed) will “not include gain or loss from the disposition of virtual currency in a personal transaction for the purchase of goods or services.”
- It will also exclude dispositions in which virtual currency is sold or exchanged for cash, cash equivalents, digital assets or other securities or commodities. The bill adds that crypto rewards derived from mining or staking will not be included in taxable income unless they are sold.
Defining India’s crypto tax regime: India does not have a regulatory framework for crypto assets but the Ministry of Finance did come up with a taxation structure in the Budget 2022-23. The government will levy a tax of 30 per cent on income from the transfer of any virtual digital asset.
- Moreover, the government did not permit loss from the sale of virtual digital assets to be set off against any other income. It has also ruled out deductions and exemptions in expenditure while computing income, except for the cost of acquisition.
- The tax regime came into effect from April 1st, following which there was a significant drop in the volume of transactions on crypto exchanges.
What can India do: The finance ministry can reexamine the taxation structure as it has attracted criticism from many stakeholders. There were murmurs that the industry was looking to approach the Supreme Court to challenge the framework, but this has gone nowhere so far.
- India can include an exemption of up to a certain limit (for example: ₹10,000) on income from crypto assets if the government does not want to permit an offset against loss.
Rolling back TDS: The government should reconsider the 1 per cent tax deducted at source (TDS)—which has left a lot of exchanges reeling from its impact since it came into effect on July 1st, 2022. The government has said that it wants to be able to track these transactions in a transparent manner but industry experts argue that the rate of 1 per cent is prohibitive.
- India can take a leaf out of the American legislation and announce a few relaxations in order to give breathing room to investors and intermediaries.
- Many exchanges have proposed reducing the TDS to 0.1 per cent in addition to bringing down the tax rate from 30 per cent, which is otherwise reserved for lottery and horse race wins.
Outlining definitions
What does the bill say: The definition laid down in the US bill explains that a digital asset means a natively electronic asset that—
“Confers economic, proprietary, or access rights or powers; and is recorded using cryptographically secured distributed ledger technology, or any similar analogue.”
- The draft also includes virtual currency, ancillary assets, and payment stablecoins under the definition.
Classifying digital assets as commodities: Moreover, the bill makes a clear distinction between digital assets that are commodities or securities.
“Digital assets which are not fully decentralized, and which benefit from entrepreneurial and managerial efforts that determine the value of the assets, but do not represent securities because they are not debt or equity or do not create rights to profits, liquidation preferences or other financial interests in a business entity (“ancillary assets”), will be required to furnish disclosures with the SEC [Securities and Exchange Commission] twice a year. Ancillary assets in compliance with these disclosure requirements are presumed to be a commodity,” read a summary of the bill.
- It also proposes an amendment to the Commodity Exchange Act to include the definition of a digital asset.
What should be India’s approach: Due to the cross-border nature of digital assets, the Indian government can ensure that the definitions in its law are aligned with global regulatory definitions.
- India’s Prime Minister Narendra Modi has repeatedly asserted at various international fora that the world needs to synchronise its regulations to rein in crypto assets.
- The Indian government is at a consultative stage of policymaking and is yet to decide which agency will provide oversight, that is, if it decides to regulate crypto assets. It remains to be seen how the government intends to classify crypto assets as the Security Exchange Board of India (SEBI) looks after both securities and commodities.
- It can amend the SEBI Act, 1992, to include digital assets under the ambit of the SEBI. It is critical to make the distinction of digital assets as categorical as possible to avoid any confusion, while also ensuring that it steers clear of a one-size-fits-all approach.
Identifying a regulatory agency
What does the US bill suggest: The bill is clear, as stated above, in specifying the CFTC’s jurisdiction over retail digital asset transactions.
“The Commission shall have exclusive jurisdiction over any agreement, contract, or transaction involving a contract of sale of a digital asset in interstate commerce, including ancillary assets,” read the draft.
- The bill specifies that any trading facility that offers or seeks to offer a market in digital assets will need to register with the CFTC as a digital asset exchange. The CFTC has been allowed to recover its costs of regulation by charging a fee.
- The draft provides legal clarity for investors, creditors, digital asset exchanges and other financial institutions about the “treatment of digital assets in bankruptcy, providing for similar treatment as commodities, and ensuring that assets are safeguarded in an insolvency.”
- There is also a provision directing interagency coordination for purposes of information sharing.
Who should India appoint: The government may want to take a leaf out of the Lummis-Gillibrand legislation as many crypto exchanges in India have batted for appointing SEBI as a regulator in the past.
- The Forwards Market Commission was the regulatory agency entrusted with looking after the commodity and futures market in India. It was merged with SEBI in 2015 and is now the Commodity Derivatives Market Regulation Department.
- There were several news reports that the Indian government was also leaning toward choosing SEBI in December 2021, when it was announced that the government was planning to table the crypto bill in Parliament.
- The regulation of crypto should be done in a coordinated manner given the complicated nature of crypto assets. It should involve multiple agencies regardless of who is selected to regulate the sector.
Ensuring consumer protections
What does the bill say: The Lummis-Gillibrand bill states that an intermediary will have to ensure that the “scope of permissible transactions that may be undertaken with customer digital assets is disclosed clearly in a customer agreement.”
- They will also have to acknowledge:
- Material source code version changes relating to digital assets before any updates,
- Manner of segregation of customer’s digital assets,
- Treatment of customer assets in a bankruptcy or insolvency scenario and the risks of loss,
- Time period and the manner in which it is obligated to return the digital asset of the customer upon their request,
- Applicable fees,
- Dispute resolution process.
- The bill also has a provision to study whether self-regulation, consistent with the Act’s provisions, can be implemented for digital asset markets.
What will be the mandate for Indian legislators: The government will have to ensure that there are adequate protections to protect investors from issues such as cyber theft of funds, the credibility of exchanges, and other concerns.
- A grievance redressal process is the need of the hour as thousands flock to the exchanges with no legal protections as of today. Many have approached the courts to no avail.
- A self-regulatory organisation along the lines of what is proposed in the Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Rules, 2021, can be explored by the government in the upcoming law, with SEBI acting as the final authority.
Dealing with stablecoins and CBDCs
What does the bill provide: The draft bill provides a framework for payment stablecoins in which companies have to maintain “high-quality liquid assets equal to not less than 100 per cent of the face amount of the liabilities of the institution on payment stablecoins issued by the institution.”
- The institution in question has to disclose the following in a publicly accessible manner:
- a summary description of the assets backing the payment stablecoin,
- the value of these assets and the number of outstanding payment stablecoins.
- The bill also has a provision for the US government to develop “standards and guidelines for executive agencies which require adequate security measures for use of the digital yuan on government information technology devices.”
Why should India regulate stablecoins: The government will need to carve out a separate section on stablecoins in the crypto bill in order to ensure that there is no risk of dollarisation.
- It is also likely that developers might want to explore a stablecoin backed by the rupee in the future if there is an increase in the number of crypto investors in India.
- The prospective law should also include a framework to ensure that the government agencies are ready to process CBDCs of other countries in a secure manner.
Fostering innovation
What is the US doing: The bill stresses that “existing law requires the Federal Reserve banks to make available payment, clearing and settlement services to any depository institution chartered under US State or Federal law.”
- This means that banks cannot discriminate against any institution which is backed by the law. The bill has a provision for a regulatory sandbox as well.
- A regulatory sandbox refers to the live testing of new products or services in a controlled regulatory environment for which regulators may (or may not) permit certain relaxations for the limited purpose of the testing.
- It calls for a joint structure in which federal and state regulators collaborate with financial technology companies to permit them to introduce innovative products into the market on a limited basis in a controlled environment.
What can the Indian government do for companies: It will be appropriate for the government to ensure that the law directs banks to ensure that all legitimate institutions in the country are able to access banking services on an equitable basis. The provision must be statutory in nature.
- There were several reports of banks refusing to offer their services to crypto exchanges due to pressure from the Reserve Bank of India. This breeds confusion and causes panic among investors in addition to the loss of potential revenue.
- The government can create a regulatory sandbox to tap into India’s talent pool and provide companies with a chance to test their products. It can also help generate employment opportunities and help India develop a base for Web3.
Also read:
- What did crypto industry experts argue against OECD’s Crypto Asset Reporting Framework?
- Summary: Crypto Asset Reporting Framework by OECD For Implementing Tax Regime
- What issues should India’s consultation paper on crypto address?
- Crypto industry urges OECD to implement framework in phases
